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February 23, 2012

11 Predictions for 2012 Election by UBS: The Issues

UBS' first report in a series looks at economic and market trends, top issues fueling debate, and the impact of election results on financial markets

Voters in Kansas mull their choices. (Photo: AP)

UBS Wealth Management recently released its first in a series of five Election Watch 2012 reports designed to guide investors through the critical issues and developments of this pivotal year for the political landscape.

The first report, written by Mike Ryan, chief investment strategistandhead of Wealth Management Research-Americas, and Kurt Reiman head of Thematic Research Wealth Management Research-Americas, delves into the economic and financial market trends that could hinge decisively on the outcomes. The report also examines the issues fueling political debate and facing the ultimate winner of the presidential election and the 113th Congress; studies the relationship between certain measures of economic activity and the margin of victory/defeat by which an incumbent president wins/loses re-election; and takes a first look at the impact of potential election results on financial markets.

Read on for UBS’ 11 predictions as we head into the election year encompassed in three main themes: the election outlook, policy issues and market implications.

ELECTION OUTLOOK

1) UBS predicts President Barack Obama will win a second term. Improving economic conditions and firming job approvalratings should help the president win the election.

2) Republicans appear poised to win a narrow majority in the Senate and to retain a slimmed-down majority inthe House.

Heading into the election, Democrats hold a narrow 53-seat majority (which includes two Independents who caucus with the Democrats) in the Senate. Of the 33 Senate seats up for re-election in November, 21 are held by Democrats, two are Independent and 10 are Republican.

With the entire House up for re-election, Democrats would need to pick up 25 seats from Republicans in order to regain the majority. This would appear to be a pretty daunting task. Keep in mind that congressional redistricting following the release of the 2010 Census data largely benefited Republicans, since the population rose in predominantly Republican-leaning states and declined in states that tend to support Democrats.

3) Expect continued gridlock, since Senate Democrats will likely retain enough seats to prevent the passage of major legislation. With broad philosophical issues about the size and role of government, compromise seems unlikely.

Republicans have a chance to gain a majority in both houses, but without a large enough margin to overcome a filibuster in the Senate, the parties will still be sharing power.

POLICY ISSUES

4) Economic policy will be central, especially job creation. While the president favors more stimulus spending,Republicans prefer tax cuts. Housing policy will alsoremain unresolved, but UBS doubts the crux of the issue–negative equity–will be addressed.

5) Dodd-Frank. While implementation of Dodd-Frank has been slow, and some Republicans, including the leading presidential contenders, have been critical of Dodd-Frank and regard it as overreach causing adverse economic results, a repeal of Dodd-Frank is unlikely as long as the Republicans fail to gain a 60-vote majority in the Senate. More likely, some provisions could be ended through the regulatory process or appropriations after the 2012 election if Republicans gain seats in Congress and control key committees. Basel III will not be impacted by the U.S. elections.

6) Fiscal imbalances are large enough to act as a drag on economic growth. However, legislation to curtail deficit spending appears unlikely given the deep ideologicaldivide. Entitlement spending, especially on Medicare,presents the biggest challenge. Fixing Social Securityappears more likely than Medicare reform, whereas taxreform is unlikely under either party. Both parties supportan extension of the Bush tax cuts, with Obama proposinghigher taxes on upper-income earners.

7) Social policy questions have been sidelined. While income inequality has grown, policies to counteract it remain controversial. Immigration and education are not among Americans’ current priorities.

8) Foreign policy has been a high point of the Obama administration. We expect that the primary campaignissues will be the standoff with Iran, eurozone disintegrationand U.S.-China trade relations. Energy policy maygenerate some controversy, despite support from withinboth parties to develop domestic energy sources.

MARKET IMPLICATIONS

9) Democratic administrations historically preside over better equity performance, but this relationship largelyappears to be the result of Republicans taking officewhen equity valuations are high.

10) Markets typically do best in the third year of a president’s term regardless of party, and equity returnsare no different when one party controls both branchesof government versus when the parties share power.

11) Bond markets do better under Republican administrations, but we believe this is largely coincidental and more the result of monetary policy.